Yellowstone Financial, Inc.

Recipe for Retirement Plan Disaster

It’s the single largest portfolio holding for many investors. Directing it wisely can make the difference between thriving and struggling in retirement. With the 2011 retirement plan year upon us, how do you go about making fund choices?

Some of us approach it like the stars of Top Chef improvising a dish — a little crushed Latin America fund here, some filleted China growth fund there, and drizzled with a flavorful commodities ETF. For those of you without a lot of investment acumen, this ad hoc approach can lead to financial indigestion.

Others think of retirement plan choices much like a spring evening at Churchill Downs. Instead of grabbing the Racing Form, investors pour over 401(k) annual reports to determine the winners from last year and pencil them in for 2011. While thoroughbreds such as Secretariat rightly become favored after blowing by the field, last year’s retirement plan champion is more likely to fall back in the pack than its cohorts.

Despite the importance of retirement plans, there are not legions of qualified advisers ready to assist you. Your company may sponsor an annual presentation on the plan. But financial advice does not work well as a broadcast. It should be tailored to the individual and coordinated with the rest of the portfolio.

Your neighborhood broker or agent may be a trustworthy source of financial advice, but many are paid through one-time and recurrent commissions on mutual funds, variable annuities, and cash value life insurance. They may desire to provide advice on your retirement plan, but are unable to do so. Even fee-only financial planners are primarily compensated as a percentage of managed assets in affiliated brokerage accounts. Your retirement plan at work usually cannot pay a fee to your investment manager.

If you can find a qualified planner who is willing to take on this work and integrate plan choices with the rest of your portfolio, their services can be invaluable. Failing that, consider these rules of retirement plan investing as you navigate through the different options.

Keep your entire portfolio in mind. Retirement plan choices should not be made in a vacuum. You must consider your spouse’s plan, as well as the rest of your IRA, Roth, and taxable investment assets. Target date fund options can be alluring, but most fail to work in concert with your other investments and may not be tax-efficient.

Concentrate first on tax-disadvantaged investments. Retirement plans, like traditional IRAs, are best used to hold positions in asset classes that are most susceptible to a tax drag. Real estate investment trusts (REITs), inflation-protected bonds, commodities, and corporate bonds can see returns decimated by taxes if held in taxable accounts. In your retirement plan, they can continue to play an important role in your portfolio without being taxed every year.

Make the “least harmful” selections. Retirement plans can have high fees, which tend to lead to lower returns over time. Look for the passively managed options that don’t attempt to beat the market, and expend high trading and research costs in the attempt to do so. Sometimes it will be easy to ferret out these plums, other times you’ll need to examine the plan documents.

Rebalance regularly. It’s important to take a look at your retirement plan balances annually to make sure you haven’t strayed too much from your desired allocation. Over the last 12 months, the stock market has been on a tear, which may have left you overweighted in equities.

Following these steps, you have a better chance than most of achieving retirement plan success over the years to come.

Dave Gardner, for the Daily Camera.